Many key tax-saving strategies need to be set up and implemented well
before Dec. 31 if you want to benefit from them in the current year.
Tax-loss selling is the classic example. Basically, this is the strategy by
which you sell investments that are in a losing position in order to
generate capital losses that you can then apply to offset capital gains in
the year. In
my previous article
I looked at how to determine if you need a tax loss in the first place, and
how to work out whether you actually have any tax losses. I’ll conclude
this series with a look at some more advanced tax loss strategies, such as
the “kiddie double play” and some traps, like the superficial loss rule.

The kiddie double play

One way to trigger losses is to transfer shares of a losing investment to
your kids. In fact, if you play your cards right, you could end up getting
a tax-reducing double play: First, you get the tax loss itself from the
flip; then, once your kids own the investment, future capital gains can be
taxable in the child’s hands, often resulting in little or no tax because
they would likely be in a lower tax bracket than you. In other words, you
get to claim the tax loss, and when the investment recovers in value, the
capital gain could be tax free.

Here’s how it works: Every Canadian regardless of age is legally entitled
to the Basic Personal Exemption, which covers off the first $11,635 of
income (for 2018). And with the 50% inclusion rate on capital gains, kids
can now earn over $22,000 of capital gains annually without paying a cent
of tax. After your kids run out of personal exemptions and the like, they
are taxed in the lowest tax bracket (assuming they have no other income).
Note that your losses can’t be used to shelter your child’s gain.

In the case of minors, remember that the strategy applies only to capital
gains. If dividends or interest are paid after the flip, the general rule
is that you must pay tax on this income until the year in which the child
turns 18 (due to the attribution rules).

To make the transaction legal in the eyes of the tax department, make sure
the investment is transferred to a separate account for the child. It’s a
good idea to have a written agreement to back up the flip, especially if
your broker insists that the transfer be made to a so-called “in-trust
account,” which is registered in the name of an adult. The paper should
document that there has been a transfer of ownership either by way of gift
or sale.

Beware the superficial loss rules!

The superficial loss rules can veto a capital loss if you’re selling on the
market to take a loss, and you buy back an identical investment within 30
days before or after the sale. Although these rules are designed to counter
artificial losses, they could apply inadvertently, for example if you sell
and then change your mind to buy in again, maybe after the stock has
dropped further.

The rules will also apply if your spouse (or a controlled company) buys
back an investment within the 30-day period, but not if a child or parent
reinvests. The rules apply not only to stocks but to mutual funds as well.
But they apply only if you repurchase an identical asset. So, if you sell
Bank A and buy Bank B, you’ll be in the clear.

Mutual satisfaction

If your mutual fund is down, one way to trigger a tax loss is to convert to
another fund within the family, e.g., from a Canadian equity fund to a U.S.
equity or money market fund. Note that tax losses can’t be claimed if the
investment is in your RRSP. However, some funds have been set up so that,
when this conversion takes place, no gain or loss is recognized for tax
purposes (of course, the idea behind this type of structure is to defer
capital gains). This should be checked out with your advisor, investment
dealer, or the fund company before you make the conversion.

Settling up

Remember that for open-market trades, the date of the tax loss is the settlement date, not when you tell your broker to sell. On
Canadian stock exchanges at least, this is three business days after the
trade date. Therefore, in order to claim a tax loss in 2018, the trade must
actually “settle” by December 31, 2018. If you’re looking to wait for the
last minute to trigger losses, be sure that you don’t miss the last
possible settlement date (what with all the holidays at the end of
December). Check with your broker on when you should actually enter the
sell order so that the transaction settles by Dec. 31. Different rules may
apply in the U.S.; and if the transaction is a “cash sale” – that is,
payment made and security documents delivered on the trade date – you may
have until later in the month.

Watch foreign currencies

When assessing whether you’re in a loss position, don’t forget that capital
gains are calculated in Canadian dollars, so currency fluctuations can be a
key consideration. If the Canadian dollar has appreciated against the
currency of the investment, there will tend to be losses.

Defer your loss until next year

One example of when you may wish to pass up claiming a loss carryback is if
you were in a lower tax bracket in earlier years than you expect to be in
the near future, and you expect to have capital gains.

Although, capital losses can be carried forward indefinitely, i.e., to be
applied against future capital gains, the further into the future your
capital gain is, the lower the “present value” of your capital loss
carryforward. So, if capital gains are a long way off, it might be better
to apply for a carryback and get the benefit of a tax refund now, even if
you were in a relatively low tax bracket.

On the flip side, if you intend to sell an investment for a capital gain
around year end, you may want to defer the gain to 2019, because you can
postpone the capital gains tax for a year. But note that you don’t have to
actually wait until the new year to do this, as long as you sell after the
year-end settlement deadline (again, check with your broker to ensure you
have the correct settlement date). One exception to this strategy will
occur if you expect to move into a higher tax bracket next year.

The foregoing is for general information purposes only and is the opinion
of the writer. This information is not intended to provide specific
personalized advice including, without limitation, investment, financial,
legal, accounting or tax advice.